London's Islamic finance future

The City of London skyline is seen behind a view of the Aylesbury Estate in south London, Britain October 15, 2015.
REUTERS/Neil Hall

REUTERS/Neil Hall

Islamic Business & Finance

With Brexit moving ahead, how well is London placed as an Islamic financial centre in the years ahead?

Professor Jason Chuah is the foremost legal expert on Islamic financial law in a western context. His scholarship on the way on which Islamic financial products are structured, received and enforced in western jurisdictions such as the UK, has been cited in some of the most important legal research undertaken on the subject in the UK and further afield. In this exclusive interview, he answers some pressing questions about the impact of Brexit on the UK as an Islamic financial centre.

How important is Islamic finance to London as a financial centre?

You would naturally expect an academic to say that ‘importance’ is a difficult term to define. What I would say, though, is that it had been government policy to place London alongside Dubai as an international Islamic financial capital. In more recent times, we have also seen the UK Government issuing an Islamic bond in 2014. A Sukuk issue valued at GBP 200 million maturing on 22 July 2019, was sold to investors. This was the world’s first sovereign Sukuk issued by a non-Islamic country and orders were already totalling around GBP 2.3 billion. In 2015, the UK also guaranteed, again for the first time, a Sukuk bond issued by Emirates Airlines. The guarantee was for a 10-year $913m issue. By any measure, that is the largest guarantee in the aviation sector by any export credit agency. Of course, relatively speaking, Islamic finance in general is still a small, but healthily growing, corner of the larger international finance tapestry.

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Does Brexit mean London will suffer as an emerging Islamic financial centre?

Under EU law, an authorisation by a member state given to a financial service provider to operate in that country will normally be also recognised in other member states. This is known as “passporting”. The question, therefore, is how important this passporting privilege is to Islamic finance providers. I do not think that Brexit will necessarily be a deterrent to Islamic financial institutions looking to internationalise their client and investor base. In terms of deposit taking, the majority of Islamic banks do not take deposits outside their home countries. Brexit is therefore not likely to be an issue for deposit taking. As to attracting investors, there is no need to be established in the EU to draw inward investments. The EU is not a homogenous market as far as Islamic finance is concerned. Islamic finance providers know the different advantages in the different Member States and pitch their business accordingly. Luxembourg, for example, already is one of the largest non-Islamic countries of domicile for Islamic investment funds. But it does not have the kind of corporate and real property advantages that the UK has. One of the important advantages held by the UK is the presence of a well-established legal system for dealing with financial contracts whether they are for Islamic or conventional finance. There are important factors for the Islamic finance provider. The UK has a tax and legal environment which is highly conducive for the unique features of Islamic finance. Brexit has of course caused some risks for Islamic financial institutions—the main one being legal uncertainty. How, and to what extent, the current banking and financial regulations which have largely been influenced by EU law will change is a relevant risk. Careful handling by the government is needed to ensure that disruption to the general financial regulatory framework is minimal.

How will Brexit affect current Shari’ah compliant debt or investment contracts?

Although from a constitutional law point of view, the change is hugely significant, it is unlikely to make performance of such contracts impossible. The economic consequences of Brexit may make performance more difficult —if say for example the pound falls even further - by making it more expensive for a UK business to repay loans expressed in a foreign currency, but under English law, a contract cannot be said to be frustrated merely on the basis that performance is uneconomic or more inconvenient. Some contracts may have so-called force majeure clauses or “material adverse change” clauses. For most borrowers or issuers of Islamic finance, Brexit or the events leading to Brexit should not materially affect their rights and obligations. Such clauses are also almost always very strictly and narrowly interpreted. If their contracts are expressed to be governed by English law, it should be remembered that general English commercial contract law is largely unaffected by EU law. That said, it is very likely that the government will put in place legislation providing for continuity of contracts.

How will Brexit affect the practise of applying Islamic law to Islamic financial contracts?

This is a controversial issue. Islamic banks and their stakeholders are always keen to see that their financial arrangements are subject to Islamic law or Shari’ah. However, the English Court of Appeal has held previously that an English court would not be in a position to enforce Islamic law even if the parties explicitly stipulate that Shari’ah shall govern the contract. That is because the English court, relying on EU law, held that parties could only choose the law of a country to govern their commercial relationship—and Shari’ah is not the law of a country. That EU law has recently been amended, though it remains arguable whether the change allows for the incorporation of Shari’ah as the governing law. If the relevant EU law in question (the so-called Rome I Regulation) no longer applies in the UK after Brexit, it is likely that the English court will nevertheless hold that Shari’ah is not merely a set of legal rules, but moral and religious principles. As such, the English court as a secular court of law would not have the competence to enforce Shari’ah in those circumstances. It is of course possible for the banks, and investor/borrowers to set out those specific Shari’ah principles they are keen to enforce properly incorporated into the contract as express terms and conditions. In this scenario, the secular court is no longer required to apply moral or religious principles, but the explicit terms and conditions of the contract.

Should Islamic financial institutions and their investors and clients anticipate Brexit by making changes to their contracts?

I think it is too early to know the full impact of Brexit on current law; it would not be sensible to provide for Brexit in the contracts, when nobody knows what Brexit really entails at this time. Mandatory legislation may be introduced which could invalidate these contractual provisions anyway. Worse still, these contractual provisions may in fact override any helpful but non-mandatory legislation introduced to help businesses in the event of Brexit. Businesses and financial institutions, whether Islamic or not, do not like uncertainty. Hence, the need to “do something” is irresistible. Some have even been talking about “flexit” clauses in their credit or loan agreements.

What are “flexit” clauses?

These are clauses introduced into loan agreements which permit lenders, including those who provided finance without seeking interest return on the capital, to increase the margin (or collateral) on loans in the event of Brexit. The usefulness of such a clause depends entirely on what the contract defines Brexit to be. Given that we don’t yet know what Brexit will look like, such clauses are at best a stab in the dark. As far as Islamic finance is concerned, not all products lend themselves to an increase in the margin. There is also some doubt as to the legality of the right to increase the margin unilaterally in Shari’ah.

Any concluding thoughts?

Far too many people are talking about doomsday scenarios and the like for the City of London. On the contrary, I have to say that Islamic finance providers, including some of the largest Islamic investment funds, have taken the line that Brexit could very well bring about different opportunities especially with the UK being more than ever before, keen to attract inward investment. Still, some others might well wish to take a “wait and see” approach to investing in the UK.